What is inflation?

Inflation occurs when too much money chases too few goods. When people have a lot of cash and not that much to spend it on, they often bid up prices. A small but positive inflation rate is economically useful, while high inflation tends to feed on itself and to impair the economy’s long-term performance.

Role of the Monetary Policy Committee (MPC)

The MPC is constantly assessing and forecasting the rate of inflation to avoid spikes and engineer a “soft landing” — a state of Goldilocks perfection, in which growth is neither too fast nor too slow, and prices are just right.

These processes don’t happen overnight, but incrementally and slowly over time, with many contributing factors. This is why the MPC must meet regularly to keep an eye on economic trends. They find that inflation is best for the South African economy when it sits between 3% to 6%, with an annual headline inflation target of 4.5%.

How do interest rates influence inflation?

Interest rates are one aspect that can influence inflation (along with fiscal policy, production costs, supply chain disruption and increase in money supply). By raising rates, the SARB is trying to make you slow down your spending. That happens when the cost of money goes up for a car loan or mortgage or something else you want to spend money on.

At some point, you’re going to pull back. The higher cost of money reduces your purchasing power — what you can afford to buy — and the MPC is effectively urging you to buy less. With less buyers in the market, demand for goods goes down and so does inflation.

However, if inflation is too low, the price and production of goods decreases. An economic slowdown associated with a decline in the rate of inflation could deteriorate into an outright recession. Additionally, if interest rates go high enough for long enough, economic growth will slow and some people will lose their jobs.

How interest rate increases can cause unemployment and GDP to decline

If a future drop in inflation is forecasted, this is when the MPC will (theoretically) drop interest rates, to help increase credit-financed consumer spending again.

How interest rate reduction causes prices of goods to rise

As you can see, inflation at both the higher and lower end are bad for the economy.

So what’s the best kind of investment in a cyclic market economy?

Real estate, energy commodities and value shares have historically outperformed during periods of high or rising inflation. Unfortunately, this disproportionately affects the poor as they are less likely to own assets like real estate – which has traditionally served as an inflation hedge.

Although property ownership may require a mortgage bond, which is affected by the rising prime rate, it is still a form of secured “good” debt that consumers should prioritise. In contrast, credit cards and personal loans which typically carry a higher rate linked to prime, will become much more costly for consumers.

The best thing consumers can do is convert as much of their unsecured “bad” debt to asset-based debt, like owning a property. The catch is to buy a property in a good investment area that you can afford.

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